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Airdrop Taxes 101: What Investors Need to Know

Airdrop Taxes 101: What Investors Need to Know

Receiving an airdrop can bring cryptocurrency users thousands of dollars of value in an instant. However, the rewards come with an associated tax liability. 

In recent years, an increasing number of cryptocurrency projects have airdropped tokens to users. While it can be a great way to reward early adopters and true believers, it can also become a headache for investors filing their tax returns. 

In this guide, we’ll break down the IRS’s guidance on airdrop taxes (and share a couple of tips on avoiding airdrop-related tax issues). 

What is an airdrop? 

In an airdrop, cryptocurrency projects freely distribute tokens to early users and investors. It’s seen as a way to build awareness for the project, reward early evangelists, and foster a burgeoning community. 

Many successful cryptocurrency projects have leveraged airdrops. In September 2020, the decentralized exchange Uniswap airdropped 400 free UNI tokens to early users. More recently, in November 2021, Ethereum Naming Service (ENS) airdropped the ENS governance token to all users who had previously purchased an ENS domain. In both scenarios, recipients of these airdrops reaped thousands of dollars of value.

How are airdrops treated from a tax perspective?

IRS guidance states that new cryptocurrency units received from airdrops following a hard fork should be taxed as income. 

Although the IRS has not issued guidance for all types of airdrops, it’s generally accepted among tax professionals that airdropped cryptocurrency rewards should be treated as ordinary income based on fair market value at the time of receipt and taxed based on the individual’s tax bracket. 

Airdrop taxes

Typically, cryptocurrency investors are used to reporting taxes only in the case of a disposal, such as a sale or trade. However, it’s important to keep in mind that airdrops need to be reported as income even if there is no disposal event. 

Where do I report airdrop rewards on my tax return? 

For most investors, airdrop rewards should be reported on Form 1040 Schedule 1 as ‘Other Income’. A description such as “crypto airdrop”, should be entered on the line item.

When should I recognize income from an airdrop?

In some situations, it’s not clear when you should recognize income from an airdrop. Let’s explore a couple of common scenarios that may cause confusion. 

What if my airdrop rewards had no fair market value? 

In some cases, your airdrop rewards might not have a fair market value at the time you receive them because they are not yet being actively traded. If you find yourself in this situation, you can instead use the fair market value at the time a market does become readily available. 

What if I had to claim my airdrop rewards? 

In some cases, it may be difficult to tell when you ‘received’ your cryptocurrency and what fair market value you should use when calculating your income. 

For example, some airdrops require users to pay a gas fee to claim their rewards. The IRS has not given explicit guidance on whether crypto investors should recognize income at the time the airdrop becomes available or at the time the rewards are claimed. 

It’s likely that the IRS will require investors to recognize income when they have ‘dominion and control’ of their assets — in other words, when they can sell or trade their tokens freely. The moment when investors get ‘dominion and control’ may vary depending on the specific mechanisms of the airdrop. 

If you’re not sure when you should recognize your airdrop income on your taxes, you should reach out to your tax professional with details about your specific situation.

Does airdrop income get taxed twice? 

Just as you would report gain or loss on the sale or exchange of any token, you would also report the gain or loss on the sale or exchange of an airdropped token. You are not, however, taxed on the same income twice.

As mentioned earlier, airdrop rewards are taxed as ordinary income based on their fair market value at the time they are received. If a disposal occurs, you will only be required to incur capital gains or losses based on how the price of your tokens has changed since you originally received them. 

Here’s an example of how this works. 

Cryptocurrency airdrop income and gains tax example

How do I determine my cost basis for my airdrop? 

As shown in the example above, your cost basis going forward for your airdropped tokens is equal to the amount of income you picked up when claiming the airdrop on your taxes. You can calculate this by finding the fair market value of the tokens at the time of the airdrop. 

How are NFT airdrops taxed? 

While the IRS hasn’t given out clear guidance on NFT airdrops, it’s reasonable to assume that they’ll be taxed the same way as other crypto airdrops. You’ll likely recognize income based on the airdropped NFT’s value at the time of the airdrop or at the time a market becomes available. 

Common airdrop issues 

While airdrops can be a great way to reward crypto investors, they often come with their own tax-related issues. Here are three common ones. 

The price of my airdropped tokens has declined significantly 

Remember, you will be required to pay income taxes based on the fair market value of your tokens at the time they were airdropped to you. However, this may be an issue if the token’s price declines significantly. In this case, it’s possible that you may need to pay more money in taxes than you currently have available. 

To avoid this scenario, we recommend using a crypto tax software that can help you track your tax liability throughout the year. 

I received an airdrop I didn’t want 

Occasionally, projects may airdrop unsolicited tokens to crypto investors. 

In most cases, these tokens have very little value. If there is a fair market value attached to these tokens, you should report it on your tax return. Usually, this will only be a few dollars of income. 

I lost money in an airdrop scam 

Airdrops can be used to scam unsuspecting cryptocurrency investors. Some phony projects ask for investors’ private keys, then use this information to steal the assets contained within their wallets.

Unfortunately, these types of ‘casualty losses’ typically can’t be deducted from your tax return. 

If you’ve been the victim of an airdrop scam, check out our guide for how to report lost or stolen cryptocurrency on your tax return

How will the IRS know if I got an airdrop? 

Some investors choose not to report airdrop rewards, believing that the IRS will not be able to trace the transaction. 

However, not reporting airdrop rewards is a form of tax evasion and could come with severe consequences. 

The IRS employs the services of third-party companies such as Chainalysis to match anonymous wallets to investors. Not reporting your income increases the risk that you’ll face a cryptocurrency tax audit and possibly face jail time. 

File your crypto taxes in minutes 

With CoinLedger, reporting airdrops on your taxes is easier than ever. The platform allows you to report income from airdrops in minutes. 

Airdrop taxes in CoinLedger

In addition, you can automatically import transactions from exchanges such as Coinbase, Kraken, and Gemini. When tax season rolls around, you’ll be able to generate a complete crypto tax report in minutes. 

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